SME R&D Tax Credits are to Merge into RDEC – What does it mean for your claims?

Over the past few years there has been a raft of changes to the R&D schemes and this is set to continue, as Jeremy Hunt announced in the Autumn Statement 2023 that the mooted merger of the SME scheme into the RDEC scheme, is going ahead. Inevitably the merger is accompanied by more changes.

The amended RDEC rules come into force for company accounting years starting on or after 1st April 2024.

The biggest change relates to subcontracted R&D

This has always been one of the more complex areas to understand and it looks set to remain that way, but with some significant changes.

SMEs can no-longer claim as a subcontractor on large company R&D projects

In simplified terms, large companies claiming R&D project costs under RDEC (the large company Research and Development Expenditure Credit) could not claim the costs of hiring 3rd party contractors to undertake their R&D activities (except in a few specific circumstances). However Small & Medium Enterprises (SMEs) that were undertaking R&D as a third party subcontractor for a large company, could claim their associated R&D costs, but they had to make their R&D claim under RDEC, not the more generous SME R&D scheme. All this will change.

Under the merged RDEC scheme, the contractor that is leading the R&D project will be able to include costs of hiring 3rd parties to undertake its R&D. This will eliminate R&D claims from SMEs that are acting as subcontractors to large companies.

The subsidised R&D rule that applied to SME is to go

This is good news as HMRC inspectors have become increasingly draconian in interpreting what constitutes subsidised R&D, leading to disputes during compliance checks and several cases getting caught up in Tribunals.

Historically SMEs must hold the commercial risk on any R&D projects they claim under the more generous SME scheme. If they did not hold the commercial risk, e.g. because their R&D was subsidised through acting as an R&D subcontractor to a large company, or because they had grant funding for their R&D, they had to claim under the less generous RDEC. And due to?the RDEC subcontracting rule (covered in the above section) this meant they could not claim the costs of hiring 3rd party contractors to undertake their R&D activities. This is despite the fact that their subcontractor costs would have been claimable if they were claiming under the SME scheme.? This will change under the merged RDEC rules and in ways that are broadly helpful to SMEs.

Under the merged RDEC rules, if an SMEs’ R&D is being subsidised either through delivering a non-R&D contract (i.e. the R&D is initiated by the SME not its client), or due to having grant funding, they will now be able to make an R&D claim without any reduction in value.

Additionally under the merged RDEC scheme (in light of the new subcontracted R&D rules covered above) SMEs undertaking subsidised R&D (as per the above examples), will be able to claim the cost of hiring 3rd party contractors to undertake their R&D.

R&D carried out by subcontractors who are working for non-UK taxpayers, such as overseas companies, will continue to qualify for R&D relief.

R&D intensive company claims boosted, but is it simple?

The Government has always maintained that one of the main purposes of merging the two schemes is to achieve greater simplicity.

Before the deep cut in the value of the SME R&D claim rate, which took effect at the start of this fiscal year, HMRC backtracked by introducing a higher claim rate for ‘R&D intensive companies’. It's still not as high as the claim rate was before the cut, but at least an improvement for some loss making companies.

That R&D intensive SME companies are being given special consideration, is good news, except that it means that the aim of simplifying claims under one scheme, is not achieved, as there is still going to be two schemes:

1. The merged RDEC scheme
2. SME intensive scheme.

In the spring budget R&D intensive companies were classified as loss making companies where more than 40% of total annual expenditure was spent on qualifying R&D. Under the merged scheme this will reduce to 30% of expenditure, meaning more companies will qualify as ‘R&D intensive’ and benefit from the higher claim rate.?

What are the claim rates and how will they change for SMEs?

Following the cut in SME claim rates applicable for expenditure from 1st April 2023, the claim rate/value for R&D intensive companies is around 27p for every ￡1 spent on R&D. This will continue.

Following the increase in the RDEC claim rate also applicable for expenditure from 1st April 2023 and continuing under the new merged scheme, the claim rate/value is around 15p for every ￡1 spent on R&D.

Profitable SMEs claiming under the merged RDEC scheme, because of the change in how the benefit is calculated, will see their claim values go down, from a maximum (at the 25% tax rate) of 21.5p per ￡1 spent, to the REDC rate of around 15p per ￡1 spent on R&D.

There is a lot of complexity to unpick and take account of going forward and some of us see this as a lost opportunity. Instead of designing a new simplified scheme we still have two schemes. However some of the changes do make sense so it's not all bad news. I just wish that the SME claim rates could be improved, as SMEs generally need more investment support than large companies with big R&D budgets.

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